The recent Court of Appeal judgement in Aviva Insurance Limited v Hackney Empire Limited acts as a useful reminder of the need for clarity when drafting side agreements.

The facts of the case

Hackney employed building contractor STC to renovate a theatre under a JCT contract. STC subsequently put in place a performance bond in favour of Hackney with insurance group Aviva. The project was severely delayed, and STC submitted several unsubstantiated loss and/or expense claims and threatened adjudication.

To assist STC and the project, Hackney ‘loaned’ the contractor £750,000 under a separate agreement. In the event that STC’s loss and expense claims were substantiated under the building contract, the money could be retained as payment.

STC went into administration before the works were complete. Hackney terminated the contract and appointed another contractor to complete the works. Hackney then claimed the full value secured by the bond on the basis that its losses exceeded that total.

Aviva disputed the claim and argued it was discharged from liability given Hackney’s extra-contractual payments to STC. Further, it argued that, giving effect to clause 27.8 of the contract, Hackney could either operate the clause 27 machinery or claim damages for breach of contract, not both; ie it had to elect between the two remedies.

Judgement leads to Court clarification

At first instance, dealing with questions of liability, the judge held that Aviva was not discharged from liability under the bond as Hackney had not acted in a prejudicial manner to Aviva in relation to the contract. Aviva appealed against the decision.

On analysis of the relevant case law, the Court of Appeal clarified that a bondsman could be discharged from its liability under a bond where its interests had been prejudiced by a material variation of the original contract, or where the employer had made advance payments of the contract price, in either instance without the consent of the bondsman.

On the facts, the payment made to STC was made outside the building contract under a separate side agreement. The requirement on STC to prove its entitlement under the contract remained. As the payment was not made under the building contract, Aviva’s interests under it had not been prejudiced and its liability was therefore not discharged.

Turning to the issues of quantum, it was common ground that Hackney could recover liquidated damages. The court disagreed with Aviva’s argument that Hackney had lost the right to recover any general damages by electing to determine STC’s employment.

“The case also strengthens the position of subcontractors in instances where a contractor becomes insolvent”

The court held that clause 27.8 of the contract did not demand an election between the two remedies. If it were intended to require an election, it should have stated so in terms.

The court also recognised an employer’s contractual right to pay subcontractors directly in respect of work done after a contractor has left site, and held on the facts that this did not give rise to an unlawful preference.

Importance was placed on the fact that STC was in administration not liquidation and the administrator had given no notice of a proposed distribution at the time.

Aviva’s appeal was therefore dismissed.

Decision highlights need for clarity

The case acts as a useful reminder of the need to have clarity when drafting side agreements.

It may have an impact on the approach taken to drafting performance bonds in the future. The law reviewed in the judgment was based on 19th century cases and it was recognised that modern commercial life may mean industry needs to adopt a different approach in the future.

It also strengthens the position of subcontractors in instances where a contractor becomes insolvent, as the court recognised the employer’s right to pay subcontractors directly under this JCT form and rejected the suggestion that to do so in such circumstances gives rise to an unlawful preference.